Question 1

Satranga Foods Private Limited is engaged in manufacturing of pickles. The auditors of the company have planned audit procedures in respect of recognition of revenues of the company. Despite that, there is a possibility that misstatements in revenue recognition are not identified by planned audit procedures. Identify and explain that particular risk in detail.

Accepted Answer

The particular risk identified is **Detection Risk** - the risk that the auditor's planned audit procedures will not identify a material misstatement that exists in the revenue recognition assertions of Satranga Foods.

**Detection Risk and the Audit Risk Model:** Detection risk is a key component of the Audit Risk Model outlined in SA 200 "Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing." The Audit Risk Model is: Audit Risk = Inherent Risk × Control Risk × Detection Risk. Unlike inherent risk and control risk, which are characteristics of the entity's business environment, detection risk is the only component that the auditor can directly control and manage through appropriate audit procedures.

**Why Detection Risk is Significant for Revenue Recognition:** Revenue recognition is typically classified as a high-risk assertion due to inherent complexities and susceptibility to misstatement. At Satranga Foods, detection risk becomes particularly important because planned procedures may fail to detect misstatements arising from:

• Timing of revenue recognition (cut-off issues)
• Completeness of recorded sales transactions
• Validity of sales returns or allowances recognized after period-end
• Terms embedded in sales agreements that affect revenue measurement
• Possibility of unauthorized side agreements
• Pressure to achieve revenue targets

**Factors that Influence Detection Risk:** Detection risk is influenced…

Question 2

IT related risks can have an impact on audit. In what different ways, such risks can have an impact on audit of financial statements?

Accepted Answer

IT-related risks can impact financial statement audits in several significant ways:

**1. Impact on Risk Assessment (SA 315)**
The auditor must understand the IT environment to identify and assess risks of material misstatement. Complex IT systems with weak controls increase inherent risk. IT vulnerabilities such as inadequate access controls, poor change management, and insufficient segregation of duties in automated systems elevate the risk profile and affect overall audit risk assessment.

**2. Weakening of Control Environment**
IT controls form an integral part of the control environment. Deficiencies in IT governance, such as absence of user access reviews, lack of system segregation of duties, inadequate authorization procedures, and poor monitoring controls, substantially weaken the overall control environment. This necessitates increased audit procedures and lower reliance on management's controls.

**3. Impact on Testing Strategy**
Weak IT controls reduce auditor reliance on automated controls and require a shift toward more extensive substantive procedures. Testing automated controls becomes complex and may require engagement of IT audit specialists. The auditor may need to employ Computer Assisted Audit Techniques (CAATs) to test the integrity of data and controls.

**4. Risk of Material Misstatement**
IT risks directly increase the risk of material misstatement through:
- System failures leading to incomplete or inaccurate transaction recording
- Data integrity is…

Question 3

CA Kanika audited books of accounts of Engineering Ltd. for the financial year 2022-2023. The auditor used an audit procedure according to which all the documents and records maintained by the company were checked in detail to obtain audit evidence. Explain the audit procedure used by the auditor. Comment on reliability of audit evidence obtained by performing such an audit procedure in some situations.

Accepted Answer

The audit procedure used by CA Kanika is **Inspection**, as defined in Standard on Auditing (SA) 500 – Audit Evidence. Inspection involves examining records, documents, and tangible assets maintained by the company to obtain audit evidence about the existence of transactions, assets, and their accuracy.

**Nature of Inspection:**
Inspection is the examination and review of records and documents (whether of internal or external origin) and the physical examination of tangible assets. It includes detailed checking of source documents such as invoices, purchase orders, payment vouchers, contracts, bank statements, fixed asset records, and inventory records to verify the authenticity, completeness, and accuracy of transactions and balances recorded in the books of accounts.

**Types of Inspection:**
1. **Inspection of Records and Documents** – examining source documents, books of accounts, registers, and supporting vouchers
2. **Inspection of Tangible Assets** – physical examination and verification of fixed assets, inventory, cash, securities, and other physical assets

**Reliability of Audit Evidence from Inspection:**
The reliability of audit evidence obtained through inspection varies depending on the nature and source of the document or asset being inspected.

**Situations of High Reliability:**
Inspection provides **highly reliable audit evidence** when documents are **externally generated** (e.g., bank statements, supplier invoices, third-party confirmations), as they are …

Question 4

CA J is conducting statutory audit of Gemini Ltd engaged in manufacturing of pharma products. The company is fairly large one and has a well-functioning internal audit department. While considering sending out external confirmation requests to trade receivables outstanding as on date of financial statements, CA J has delegated the process of choosing trade receivables, designing requests and receiving responses from customers to internal audit department. The responses are also received on the mail id of internal audit department. Is the approach of CA J proper?

Accepted Answer

**No, the approach of CA J is not proper.**

Under **SA 505 (External Confirmations)**, the auditor must maintain control and responsibility over the external confirmation process. Specifically, SA 505 requires that the auditor should:

**Auditor's Responsibility:**
The auditor is responsible for determining the need for external confirmations, designing the confirmation requests, selecting the items to be confirmed, and evaluating the responses received. These are core audit functions that cannot be delegated to the internal audit department.

**Issues with CA J's Approach:**
1. **Loss of Audit Control:** By delegating the selection of trade receivables to internal audit, CA J has relinquished control over which items are subjected to confirmation. This prevents the auditor from exercising independent judgment in selecting a representative sample based on audit risk considerations.

2. **Design of Requests:** SA 505 requires the auditor to design confirmation requests to elicit responses that provide relevant and reliable audit evidence. The internal audit department may design requests biased toward management's interests rather than the auditor's independent assessment of what information is needed.

3. **Receipt of Responses:** Responses received directly by the internal audit department (on their email) creates a serious control weakness. The auditor cannot verify the authenticity of responses or ensure that no manipulation occurred. Responses should be received directly…

Question 5

The newly appointed auditor of BTN Limited wants to obtain sufficient appropriate audit evidence about whether the opening balances contain misstatements that materially affect the current period's financial statements. What audit procedures should he perform for this purpose?

Accepted Answer

**Opening Balances - Definition and Significance:** Opening balances are the account balances at the beginning of the period, which represent the closing balances of the prior period. The auditor must obtain sufficient appropriate audit evidence to determine whether opening balances contain misstatements that could materially affect the current period's financial statements, as per **SA 510 - Initial Audit Engagements—Opening Balances**.

**Key Audit Procedures:**

**1. Review of Predecessor Auditor's Work (if applicable):** The auditor should review the audit file of the predecessor auditor and the prior year's financial statements and audit report. This helps understand any adjustments made, identified errors, or unusual transactions. The auditor may discuss with the predecessor auditor (with the auditee's permission) to understand the nature of accounts and any significant matters identified in the prior year.

**2. Examination of Accounting Records and Source Documents:** The auditor should examine the general ledger, subsidiary ledgers, and journals to understand the nature of transactions leading to opening balances. Supporting documents for material items should be reviewed to verify their authenticity and accuracy. Transactions near the year-end should be examined to ensure proper cutoff and classification.

**3. Analytical Procedures:** The auditor should perform analytical procedures on opening balances by comparing them with prior year's closing balances and invest…

Question 6

SPR Ltd has been into the media business since 2001. During the F.Y 2022-2023, many notices were received by the company for hurting public sentiments and financial claims were filed against the company. As an auditor of the company, you requested the management for arranging the meeting with company's external legal counsel. Management is of the view that such meetings are necessary in certain circumstances only. Can you list down such circumstances?

Accepted Answer

As an auditor of SPR Ltd, meetings with external legal counsel are necessary in specific circumstances to obtain direct and independent evidence regarding litigation and claims affecting the company. These circumstances include:

**Existence of Notices and Claims**: When the company has received notices or financial claims have been filed against it (as in the present case), the auditor must meet with legal counsel to understand the nature, timing, and potential financial impact of such claims.

**Pending or Threatened Litigation**: When litigation is pending or threatened, the auditor needs to assess the probability of an outflow of economic resources and whether a provision should be recognized in the financial statements or disclosed as a contingent liability under the applicable accounting standards.

**Contingent Liabilities Assessment**: To determine whether contingent liabilities should be: (a) provided for in the financial statements; (b) disclosed as contingent liabilities; or (c) neither provided nor disclosed, depending on the probability and measurability of the obligation.

**Verification of Management Representations**: The auditor should meet with legal counsel to corroborate and verify management's representations about the existence, status, and likely outcomes of litigation and claims, ensuring completeness and accuracy of disclosures.

**Uncertainty Regarding Outcomes**: When there is uncertainty about the probable outcomes or the quantification of potentia…

Question 7

Proceedings have been initiated against False Limited for holding benami property under law relating to prohibition of benami transactions and the rules made thereunder but such property is not recorded in books of accounts. As a consultant to the company, what will you advise the company as far as disclosure requirements are concerned in financial statements in relation to said proceedings?

Accepted Answer

**Advice to False Limited on Benami Property Disclosure in Financial Statements**

**1. Schedule III Disclosure Requirement:**
Under Schedule III, Part II of the Companies Act, 2013, contingent liabilities (not provided for) must be disclosed in the Notes to Accounts. The proceedings initiated against False Limited under the Prohibition of Benami Property Transactions Act, 1988, constitute a contingent liability requiring mandatory disclosure, regardless of whether the property is recorded in the books of accounts.

**2. Applicable Accounting Standard — AS 29:**
AS 29 (Provisions, Contingent Liabilities and Contingent Assets) governs the treatment. The classification depends on probability: If the outcome is **probable** and the financial effect can be reliably **estimated**, a Provision should be recognized (liability in the Balance Sheet). If the outcome is **possible** but not probable, or the amount cannot be reliably estimated, it must be disclosed as a **Contingent Liability** in Notes. If the outcome is remote, disclosure may not be required.

**3. Mandatory Disclosures to be Made:**
(a) Nature of the proceedings and the statutory basis (PBPT Act, 1988 and Rules thereunder)
(b) Description and financial effect of the property alleged to be benami
(c) Current status of the proceedings
(d) Estimated quantum of potential penalty, confiscation, or financial liability, if ascertainable
(e) Any amounts already provided for in the accounts
(f) Whether the property involves re…

Question 8

Droma Shoes Private Limited was established in year 2022-23 for manufacturing of footwear. As funds were needed to carry on its business activities - including for purchase of different raw materials, incurring of regular expenses like power and fuel and payment of wages etc., it had got sanctioned a credit facility amounting to Rs. 2 crores repayable on demand from a bank against primary security of its current assets and collateral security of residential house of one of its directors. Duly signed guarantee documents by directors in favour of bank also form part of bank's loan documentation. Account statement of above facility downloaded from bank's website shows debit balance of Rs. 1.85 crores as on 31st March, 2023. The operations in above credit facility are satisfactory. In this reg…

Accepted Answer

The credit facility in question is a **Cash Credit** facility, commonly referred to as a **Working Capital Credit Facility** or **Demand Credit** in banking terminology. It is a revolving credit arrangement specifically designed for financing working capital needs of manufacturing operations.

**Part (i): Nomenclature and Reflection in Financial Statements**

The facility is known as a **Cash Credit Facility**. In the financial statements of Droma Shoes Private Limited as on 31st March 2023, this amount should be reflected and classified as follows:

**Classification**: The outstanding balance of Rs. 1.85 crores should be classified as a **Current Liability** under **Secured Borrowings** in the Balance Sheet. This classification is based on the repayable-on-demand nature of the facility, which makes it payable within 12 months from the balance sheet date. Although the sanctioned limit is Rs. 2 crores, only the actual outstanding balance of Rs. 1.85 crores represents the liability to be recognized in the balance sheet as on 31st March 2023.

**Nature of Borrowing**: The borrowing is **Secured** in nature as it is backed by primary security of current assets and collateral security of a residential house of one of the directors. The fact that directors have also executed personal guarantee documents further strengthens the security position of the lender.

**Part (ii): Schedule III Disclosure Requirements**

Schedule III of the Companies Act, 2013 prescribes specific disclosure…

Question 9

Following is extract of notes to accounts of financial statements of STU Private Limited listing some ratios. Discuss, whether disclosure, given in following manner meets requirements of Schedule III of the Companies Act, 2013. Ignore other ratios which are not listed in extract given below: Current ratio 31.3.2023: 2.50, 31.3.2022: 2.30; Inventory turnover ratio: 3.00, 6.00; Trade receivables turnover ratio: 1.75, 5.00; Net profit ratio (in%): 13%, 10%.

Accepted Answer

**Analysis of Ratio Disclosure Compliance with Schedule III, Companies Act 2013**

**Schedule III Requirements:**
Schedule III of the Companies Act, 2013 mandates disclosure of specified financial ratios in the notes to accounts. The revised Schedule III (post-2017 amendments) requires that each ratio disclosure include: (1) the **name of the ratio**, (2) the **formula or components** showing numerator and denominator, (3) **comparative figures** for current and preceding year with clear date identification, and (4) appropriate **units** (percentage, times, etc.).

**Deficiencies in the Given Disclosure:**

**1. Missing Formula/Components:** The disclosure does not specify the calculation method for any ratio. For example, Current Ratio should show "Current Assets ÷ Current Liabilities"; Inventory Turnover Ratio should clarify "Cost of Goods Sold ÷ Average Inventory"; Trade Receivables Turnover Ratio should indicate "Net Revenue ÷ Average Trade Receivables"; and Net Profit Ratio should show "Net Profit ÷ Net Revenue". Schedule III explicitly requires this breakdown to enable users to verify calculations and understand the basis of computation.

**2. Inconsistent Year Identification:** The Current Ratio properly identifies years with dates (31.3.2023 and 31.3.2022), meeting Schedule III requirements. However, the other three ratios present only numerical values (Inventory: 3.00, 6.00; Trade Receivables: 1.75, 5.00; Net Profit: 13%, 10%) without clear year delineation. Readers …

Question 10

Rajni, a CA student, has understood that SA 230 requires auditor to prepare audit documentation on a timely basis. While reading about SQC 1, she notices that time limit for completion of final audit file is ordinarily not more than 60 days after the date of auditor's report. She finds it to be puzzling. Unable to comprehend, she seeks your guidance. Guide her.

Accepted Answer

Rajni's confusion is understandable as both provisions address audit documentation, but they operate at different stages of the audit process.

**SA 230's Requirement - Timely Preparation During Audit:**
SA 230 (Audit Documentation) requires auditors to prepare audit documentation on a **timely basis during the course of the audit**. This means as audit procedures are performed, working papers must be contemporaneously documented. Timely documentation ensures accuracy, enables effective supervision, and creates a proper record of evidence obtained. The emphasis is on preparing documentation **concurrently with the audit execution**, not in arrears.

**SQC 1's Requirement - Final Assembly After Audit:**
SQC 1 (Quality Control for Firms) addresses quality control procedures. The 60-day rule refers specifically to the **completion of the final audit file ordinarily within 60 days after the date of the auditor's report**. This is about finalizing and assembling the audit file for archiving and quality review purposes after the audit has concluded and the report has been issued. This allows for administrative steps like organizing cross-references, indexing, ensuring completeness, and preparing for archival.

**How Both Coexist Without Contradiction:**
The apparent puzzle dissolves when we recognize these address **different phases**:

1. **During Audit Phase (SA 230):** The auditor continuously prepares working papers, records findings, documents evidence, and maintains audit tra…

Question 11

Discussing meaning of completion memorandum, elaborate upon its importance.

Accepted Answer

A **completion memorandum** is a final summary document prepared by the auditor, typically at the conclusion of the audit engagement, that consolidates significant findings, conclusions, and outstanding matters. It serves as a comprehensive record of the auditor's final assessment before issuing the audit report.

**Meaning of Completion Memorandum:**

The completion memorandum is a written statement prepared by the auditor documenting: (a) the overall conclusions reached on significant audit matters, (b) all adjustments and reclassifications made to the financial statements, (c) any disagreements or differences of opinion with management, (d) outstanding items requiring resolution, and (e) the auditor's professional judgment on the fairness and completeness of the financial statements.

**Importance of Completion Memorandum:**

**1. Quality Control Function:** It provides a critical quality control checkpoint by enabling the engagement partner to review and approve all audit work and conclusions before the audit report is finalized. This ensures proper oversight and maintains the integrity of the audit process.

**2. Consolidation of Evidence:** It brings together all material findings identified during the audit—including adjustments, contingencies, and accounting policy matters—in a single document, facilitating comprehensive review of the audit's scope and conclusions.

**3. Audit Documentation Compliance:** As per **SA 230 (Audit Documentation)**, the completion memorand…

Question 12

CA K is statutory auditor of DEMA Private Limited for the year 2022-23. The company has three plants in India. He is nearing completion of audit procedures relating to financial statements for the year under audit and has yet to sign audit report. Meanwhile, a huge fire had broken out in one of plants of the company located near Nashik on 25th June, 2023 damaging substantial part of machinery and work-in-process resulting in loss of about Rs. 5 crores. Unaware of the incident, he is in process of finalizing his report in first fortnight of July 2023. State few audit procedures to be performed by him to obtain sufficient appropriate evidence for identifying such events. Also explain auditor's responsibilities in this situation.

Accepted Answer

**Audit Procedures to Identify Subsequent Events (SA 560)**

The auditor should perform the following procedures to obtain sufficient appropriate evidence about events occurring between the balance sheet date (31st March 2023) and the audit report date (early July 2023):

1. **Enquiries of Management**: Direct enquiry from management personnel about events subsequent to balance sheet date, particularly focusing on events that could significantly affect the financial statements or audit opinion.

2. **Review of Board Minutes and Internal Communications**: Examine minutes of all board meetings and audit committee meetings held after 31st March 2023. Review internal circulars, memos, and communications regarding operational matters.

3. **Correspondence with Legal Counsel**: Enquire from company's legal advisor regarding any litigation, claims, assessments, or contingencies arising after the balance sheet date.

4. **Review of Insurance Correspondence**: Examine insurance-related communications to identify any claims, incidents reported, or coverage implications post-year end.

5. **Analysis of Post-Balance Sheet Transactions**: Review significant transactions and agreements entered into between balance sheet date and audit report date.

6. **Inquiries with Regulatory Bodies**: Inquire about any correspondence with taxation authorities, environmental regulators, labour authorities, or other regulatory agencies.

7. **Analytical Procedures on Post-Year Data**: Review management a…

Question 13

Kundan, a CA student, is part of an engagement team conducting audit of an entity. The audit procedures are nearing completion. He notices that engagement partner has asked for a cash flow forecast from management for next twelve months from date of financial statements. Keeping in view above, answer the following:

Accepted Answer

**Part (i): Purpose and Significance of Cash Flow Forecast Request**

The engagement partner has likely requested the 12-month cash flow forecast to assess the **appropriateness of management's use of the going concern basis of accounting**, as required by **SA 570 Going Concern**. This procedure is critical near audit completion because:

**Purpose:** The cash flow forecast serves as key audit evidence to evaluate whether the entity has sufficient liquidity and resources to continue operations for at least 12 months from the reporting date. It helps the auditor determine whether there are material uncertainties regarding the entity's ability to meet obligations as they fall due.

**Significance of Testing by Engagement Partner:**

Firstly, **SA 570 requires the auditor to obtain sufficient appropriate audit evidence** about the appropriateness of the going concern assumption used by management. Cash flow forecast is a primary indicator of future financial viability, making it essential that the engagement partner (the audit leader responsible for overall engagement decisions) personally evaluates this critical evidence.

Secondly, this assessment **directly impacts the audit opinion**. If the forecast reveals serious liquidity concerns or the entity cannot meet its obligations, the auditor may need to qualify the opinion, issue an adverse opinion, or include an emphasis of matter paragraph regarding going concern uncertainties. The engagement partner's judgment is therefore …

Question 14

Mention some examples of circumstances where the auditor may consider it necessary to include an Emphasis of Matter paragraph.

Accepted Answer

As per SA 706 (Emphasis of Matter and Other Matter Paragraphs in the Independent Auditor's Report), an **Emphasis of Matter (EOM) paragraph** is included in the auditor's report to draw users' attention to a matter that is appropriately presented or disclosed in the financial statements and is, in the auditor's judgment, of such importance that it is fundamental to users' understanding of the financial statements. The following are key examples of circumstances where an auditor may consider it necessary to include an EOM paragraph:

**Going Concern Issues**: When there exists substantial uncertainty about the entity's ability to continue as a going concern, but management has made appropriate disclosures in the financial statements regarding the uncertainty and the basis of preparation. The auditor highlights this to draw users' attention to the significant risks involved.

**Major Uncertainties in Legal Proceedings**: Exceptional litigation, regulatory proceedings, or claims of uncertain outcome that could materially affect the entity's financial position. The EOM directs readers to the relevant note disclosing the details, quantum, and potential impact.

**Early Adoption of New Accounting Standards**: When an entity has early-adopted an accounting standard or amendment that has a pervasive effect on the financial statements and differs from the standard adoption date, the auditor may include an EOM to highlight this significant change in accounting policy.

**Significant Re…

Question 15

CA. S, while conducting audit of an entity is facing the following issues: (i) He has not been provided with necessary support for attending inventory count process of entity as at year end. (ii) Accounts Manager is not providing him present addresses of customers as well as suppliers for sending external confirmations. Even mail ids have not been provided on the pretext of business confidentiality. (iii) He was not able to verify revenues of entity due to lack of complete details. (iv) He has been asking for bills on a sample basis for the purpose of verifying expenses, but staff has been making lame excuses. The matter was brought to knowledge of higher management, but of no avail. The auditor, CA S has come to the conclusion that the possible effects on the financial statements of undet…

Accepted Answer

**Analysis of Scope Limitations and Auditor's Response**

The auditor (CA S) is facing **scope limitations** that prevent obtaining sufficient appropriate audit evidence in multiple critical areas. SA 705 (Modifications to the Opinion in the Auditor's Report) addresses how auditors should respond when unable to gather adequate evidence.

**Nature of Scope Limitations Faced:**
The limitations are significant: inability to attend inventory count, inability to obtain external confirmations for receivables and payables, incomplete revenue documentation, and inability to verify sample bills for expense verification. These restrictions affect inventory, receivables, payables, revenue, and expenses—multiple interconnected areas of the financial statements.

**Materiality and Pervasiveness Assessment:**
The auditor has concluded that possible effects of undetected misstatements would be **material and pervasive**. "Pervasive" means the effects are not confined to specific figures but extend to multiple assertions and financial statement areas. This distinction is critical under SA 705.

**When Disclaimer of Opinion is Appropriate:**
According to SA 705, when a scope limitation exists and possible effects are material AND pervasive, the auditor shall issue a **disclaimer of opinion**. A qualified opinion ("Except for...") would be inadequate when:
- The scope limitation affects multiple areas
- Possible effects extend beyond isolated items
- The auditor cannot determine whether fair p…

Question 16

Pilfering is one of the greatest problems in any hotel and the importance of internal control cannot be undermined. Explain.

Accepted Answer

**Pilfering** refers to the unauthorized removal of cash, materials, inventory, and other assets from the hotel premises, whether by employees or external parties. It is indeed one of the most significant problems in the hospitality industry and internal control plays a vital role in its prevention and detection.

**Why Pilfering is a Greatest Problem in Hotels:**

Hotels operate with large inventories of high-value items including cash, food, beverages, linen, cutlery, crockery, toiletries, and other consumables. The nature of hotel operations—involving multiple points of sale, numerous transactions, large number of employees in different shifts, and open access to various areas—creates an environment highly susceptible to pilfering. Cash transactions are frequent and substantial, making hotels attractive targets. The 24/7 operational cycle, multiple departments, and decentralized nature of control make supervision difficult. Employees with direct access to valuable items (housekeeping staff, kitchen staff, bar attendants, maintenance workers) pose a significant risk. Pilfering directly impacts profitability as it increases cost of goods sold, reduces cash collections, and necessitates higher inventory purchases to compensate for losses. Even small-scale pilfering by multiple employees can accumulate into substantial losses. It also affects operational efficiency, creates discrepancies in records, and undermines the accuracy of financial statements.

**Importance of Internal…

Question 17

From a lessee's perspective, highlight main differences between an operating lease and finance lease only in relation to accounting treatment and tax benefits.

Accepted Answer

From the lessee's perspective, **operating leases** and **finance leases** differ significantly in accounting recognition and tax deductibility.

**ACCOUNTING TREATMENT**

Under **Ind AS 116 – Leases**, both lease types are now recognized on the balance sheet. However, they differ in depreciation approach: **Operating Lease** – The right-of-use (ROU) asset is depreciated over the **lease term**. Once the lease ends, the asset is fully written off. Interest on the lease liability is charged as a separate expense. **Finance Lease** – The ROU asset is depreciated over the **shorter of the asset's useful life or the lease term**. If useful life extends beyond the lease term, the asset may retain residual value. Interest treatment is similar to operating leases.

**TAX TREATMENT**

The tax deductibility approach differs substantially. **Operating Lease** – Under **Section 36** of the Income Tax Act, 1961, the lessee claims the **entire lease rental as a revenue expense** in the year paid. This provides an upfront tax deduction, delivering maximum tax benefits during the lease period. **Finance Lease** – Under **Section 32** of the Income Tax Act, 1961, the lessee capitalizes the leased asset and claims **depreciation** based on the applicable rate applied to the capitalized value. The **interest component** of lease payments is deducted separately as interest. Additionally, under **Section 269UA**, the lessee is deemed the owner for tax purposes if lease terms permit ownership tra…

Question 18

While conducting statutory audit of branch of a nationalized bank, it is noticed by CA Z that credit facilities granted to a borrower consisting solely of term loan have been classified as 'Sub-standard Asset' during the year 2022-23 due to failure of borrower to pay EMIs on time. Such EMIs were outstanding for more than 90 days and account was, therefore, classified as 'Sub-Standard Asset'. CA Z has also agreed to above asset classification made by branch management. What are CA Z's responsibilities regarding verification of compliance with income recognition norms by branch in respect of above credit facilities?

Accepted Answer

**CA Z's Responsibilities for Verification of Income Recognition Norms for Sub-Standard Assets**

**1. Key Principle for Sub-Standard Assets:** Once an asset is classified as sub-standard (an NPA category), the bank must follow specific income recognition norms as mandated by RBI. For sub-standard assets, **income must be recognized on a cash basis only, not on an accrual basis**. This is an automatic corollary of the asset classification itself.

**2. Primary Verification Responsibility:** Although CA Z has agreed with the sub-standard classification, the audit responsibility extends to verifying that the **corresponding income recognition norms have been strictly complied with**. These responsibilities are intertwined—classification and income recognition cannot be treated separately.

**3. Specific Audit Procedures CA Z Must Perform:**

(a) **Verify Non-Recognition of Accrual Income:** CA Z must verify that no interest income has been recognized on accrual basis for this term loan account. Any interest accrued but not received in cash must be excluded from the Profit & Loss Account and kept outside the regular income.

(b) **Review Interest Accrued But Not Received:** Examine the interest register, loan statement, and subsidiary records to identify all interest accrued but outstanding. Such accrued interest should **not be included in operating income** for the period.

(c) **Verify Income is Recognized Only When Received:** Confirm that income (principal and interest) is …

Question 19

While verifying provisions of advances of a branch of MCO Bank as part of statutory branch audit, CA Z notices that credit facilities consisting of term loan to KRT Enterprises have been classified under doubtful asset (D1) category. The outstanding balance in above term loan account as on 31.3.2023 is Rs. 50 lakhs. Value of security held in account is Rs. 40 lakhs. The branch has made provision of Rs. 7.50 lakhs. Is provision made by branch proper? Discuss.

Accepted Answer

**Provision Calculation for Doubtful Asset (D1 Category) — KRT Enterprises Term Loan**

As per **RBI's Prudential Norms on Income Recognition, Asset Classification and Provisioning (IRACP) pertaining to Advances** (Master Circular issued under the Banking Regulation Act, 1949), the provisioning requirement for a **Doubtful Asset classified under D1 category** (i.e., an asset that has remained NPA for a period up to 1 year in the doubtful category) is as follows:

- **Secured portion**: Provision @ **25%** of the outstanding secured amount
- **Unsecured portion**: Provision @ **100%** of the outstanding unsecured amount

**Computation of Required Provision:**

Outstanding balance of term loan = ₹50 lakhs
Value of security held = ₹40 lakhs

Secured portion = ₹40 lakhs → Provision @ 25% = **₹10 lakhs**
Unsecured portion = ₹50 − ₹40 = ₹10 lakhs → Provision @ 100% = **₹10 lakhs**

**Total Required Provision = ₹20 lakhs**

**Provision actually made by the branch = ₹7.50 lakhs**

**Conclusion:** The provision made by the branch of **₹7.50 lakhs is NOT proper**. There is a **shortfall of ₹12.50 lakhs** (₹20 lakhs − ₹7.50 lakhs). CA Z should report this shortfall in the Long Form Audit Report (LFAR) and also include it in the main audit report, as it represents an understatement of provisions and overstatement of profits, which is a material misstatement. The branch should be advised to make the additional provision of ₹12.50 lakhs to comply with RBI's IRACP norms.

Question 20

CA X has been offered audit of financial statements of TDK Industries, a partnership firm. Prior to accepting proposed offer, he insists upon obtaining an agreement of management regarding acknowledgment of its responsibility of having a proper process in place to ensure that financial statements prepared are free from material misstatements. However, management is of the view that it is auditor's duty to detect material misstatements in financial statements and such an insistence by auditor is totally uncalled for. Whose view is proper? Also discuss reasons for arriving at your conclusion. What should be likely proper course of action for CA X in above situation?

Accepted Answer

**CA X's view is proper and correct.** Management's view reflects a fundamental misunderstanding of audit responsibilities and is incorrect.

**Reasons for this Conclusion:**

Under **SA 210 (Agreeing the Terms of Audit Engagements)**, before accepting an audit engagement, the auditor must establish a clear understanding with management regarding their respective responsibilities. This is a mandatory professional requirement, not optional.

**Division of Responsibilities:**

Management is responsible for: (1) Preparing financial statements in accordance with the applicable financial reporting framework; (2) Establishing a proper process and internal controls to ensure financial statements are free from material misstatement, whether due to fraud or error; (3) Providing the auditor all relevant information and records.

The auditor is responsible for: (1) Planning and performing the audit to **detect** material misstatements that may exist; (2) Obtaining reasonable assurance about whether the financial statements are free from material misstatement; (3) Expressing an opinion on the financial statements.

**Critical Distinction:** Management's confusion arises from conflating the auditor's role in *detection* with responsibility for *preparation*. The auditor detects misstatements; management is responsible for ensuring they don't exist. These are fundamentally different roles. SA 210 requires explicit written acknowledgment of these boundaries to prevent the "audit expectation…

Question 21

'SA 220 is premised on the basis that the firm is subject to SQC 1'. What do you understand by given statement in context of audit quality?

Accepted Answer

**SA 220 Quality Control for an Audit of Financial Statements** establishes quality control requirements specific to an individual audit engagement. **SQC 1 System of Quality Control for Firms** establishes the firm's responsibility to design and implement a system of quality control applicable to all audit and assurance engagements.

The statement "SA 220 is premised on the basis that the firm is subject to SQC 1" means that SA 220 operates under the foundational assumption that the audit firm has already established, implemented, and is operating under the broader quality control framework prescribed by SQC 1. SA 220 is not a standalone standard; it complements and relies upon the firm-level systems established under SQC 1.

**Understanding the Premise:**

SA 220 addresses engagement-level quality control matters such as the engagement partner's responsibility, continuance and appointment of client relationships, assignment of personnel with appropriate competence, engagement performance (including supervision and review), and engagement quality review. However, SA 220 presumes the firm has already:

(1) Established overall quality objectives, policies, and procedures in accordance with SQC 1

(2) Implemented quality standards covering ethical requirements and independence

(3) Recruited, trained, and evaluated personnel with appropriate competence

(4) Established consultation procedures for complex or contentious matters

(5) Implemented monitoring activities to assess co…

CA Inter Audit & Ethics

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